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Control is instrumental to Teradyne's success

Like many electronics companies, Teradyne has outsourced the production of its high-end equipment. But that doesn't mean it has given up control of its supply chain. Far from it.

For Teradyne Inc., learning to let go was nearly a 10-year process. The company, which makes high-end precision testing instruments, first began exploring the idea of outsourcing production back in the late '90s. It finally took the plunge in 1999, contracting out the assembly of one of its simplest components, circuit boards. As its confidence in the process grew, Teradyne gradually handed off more complex tasks. But it was only last summer that the instrument maker finally agreed to entrust an outside contractor with the final two steps of its manufacturing operation.

Teradyne's caution is not hard to understand: Quality control is its stock in trade. Teradyne is the leader in the automatic test equipment sector, recording US $1.38 billion in sales in 2006. About 85 percent of its revenue comes from integrated circuit testers used by semiconductor makers; the remainder comes from assembly testers used to analyze circuit board performance. These are complex, high-end systems. The average price of one of Teradyne's devices is one million dollars, according to Jim Wood, Teradyne's director of supply chain information systems.

Over time, Teradyne has overcome its reservations about contract manufacturing—today it outsources 90 percent of its production. But it has by no means given up control over its supply chain. The North Reading, Massachusetts-based company remains deeply involved in the procurement of the materials and parts used to make its products. For one thing, the company has retained the responsibility of overseeing its extensive supply base. For another, it maintains a detailed accounting of the whereabouts of parts and materials throughout its far-flung supply chain. Teradyne accomplishes this through use of a multi-enterprise information system that gives the instrument maker visibility of inventory down to the parts being held at the suppliers' factories.

Proceeding with caution
In contrast to many high-tech companies, Teradyne initially turned to outsourcing for reasons unrelated to cost. "Lower costs weren't the initial driver because costs weren't that much different [at first]," Wood reports. Instead, Teradyne was looking to free up corporate resources to focus on more strategic matters like new product introductions, product quality, and lead-time improvements. By handing off day-to-day manufacturing responsibilities, the instrument maker wouldn't have to worry so much about buildings, equipment, and personnel. Or as Wood puts it: "Outsourcing means our management isn't focused on running factories."

Because it makes high-value equipment in small quantities, Teradyne was concerned at the outset that contract manufacturers wouldn't be interested in its business. Those fears proved unfounded. In 1999, Teradyne found a contract manufacturer that was willing to take over the assembly of printed circuits, and things took off from there. During the next nine years, Teradyne farmed out more and more of its manufacturing work. By 2006, it had handed off all but the final two steps: product configuration and the final testing of its equipment.

Teradyne's reluctance to relinquish these final two tasks can be laid to concerns about its contract manufacturer's lack of experience in testing and diagnosing problems with complex instruments. "That's pretty complicated, and it can take more than a week," Wood says, referring to the final testing process. "The argument against [outsourcing] that was that it's our secret sauce. That's the stuff that defies documentation. And you need engineers who know what they're doing."

Still, over the following months, Teradyne noticed that the contract manufacturer had embarked on a big push to upgrade its capabilities. Not only was it hiring more highlevel engineering talent, says Wood, but it was also getting better at building boards for Teradyne's products. Impressed by what it saw, Teradyne decided to let the contractor test equipment on a trial basis, starting with its simplest product line. Before the trials got under way, Teradyne put in a great deal of time training the contract manufacturer's personnel. It even got involved in the contractor's hiring process—to ensure, in Wood's words, that "they got the right level of person."

The trials got off to a good start: The contract manufacturer proved it was fully capable of handling testing for the simplest products. Based on that experience, Teradyne gradually gave it responsibility for testing increasingly complex products. Last summer, the instrument maker finally completed the handover of the testing process.

And then there was one ...
In the early years of its outsourcing initiative, Teradyne used two contract manufacturers. It has since pared that down to one, Singapore-based Flextronics. "It's easier to have one contract manufacturer," says Wood, "because it's easier to manage the relationship."

Flextronics currently operates two plants in Charlotte, North Carolina, USA, and a third facility in Suzhou, China, on Teradyne's behalf. One of the Charlotte facilities makes boards; the other assembles products. The Suzhou factory, by contrast, handles the building, assembly, and testing of Teradyne's major product line all under one roof.

Teradyne set the stage for its 2006 move into China by reconfiguring its supply chain. In 2004, it began establishing a supply base in Asia. "The strategy was to first develop the supply base and then move assembly over there," Wood explains.

Although Flextronics buys routine material and executes purchase orders, its role in procurement is limited. Teradyne remains deeply involved in the procurement of the materials and parts used to make its products—particularly the special, high-value parts, which cost as much as $90,000 apiece. Over the years, Teradyne has developed strong relationships with its key suppliers, which it feels are in its best interest to maintain. "We have more leverage and expertise with them," says Wood.

As an example, Teradyne handles the procurement of customdesigned parts known as application- specific integrated circuits, or ASICs. "These are very high-dollar, carefully managed parts with long lead times," Wood says. "We have a dedicated group that does nothing but worry about ASICs."

Managing the supply base
Staying close to suppliers helps Teradyne deal with variable demand, which has become a growing problem in recent years. In the past, Teradyne sold its testing equipment directly to the companies that manufactured integrated circuits. Now, however, those manufacturers have outsourced the testing of their integrated-circuit products to third parties known as test houses. Wood explains that test houses often place inquiries for equipment before they have actually won a contract from the semiconductor maker for the work. "It makes forecasting kind of tricky because there may be only one order out there, and three people are competing for it," he says.

Further complicating matters is the need for speed. Once a test house receives a contract, it generally wants its new testing equipment delivered right away. But Teradyne's ability to respond swiftly depends largely on its suppliers' ability to come through with the necessary parts, some of which have long lead times. The company realized it had to figure out a way to avoid delays in obtaining critical components— particularly those too costly to stockpile as buffer inventory.

Teradyne's solution was to reach back into the supply chain and begin working with key suppliers to assure they have sufficient stock on hand to meet sudden demand. To that end, it created a special unit, dubbed Supply Chain Express, whose mission is to ensure that suppliers are prepared to respond promptly to orders for their parts. The Supply Chain Express team studies the supplier's own production process to gain a full understanding of the materials planning and manufacturing issues the supplier faces. "We get into their bills of material and understand their [the supplier's] factory and work collaboratively with them," Wood explains. The team may also authorize the supplier to build parts in advance of a purchase order from Flextronics.

Not all of those parts end up being used, however. So to protect its key suppliers from getting stuck with materials that Teradyne doesn't end up buying, the instrument maker has an arrangement to cover those costs. "We have a contractual liability [to pay for] them, so if the demand goes away, the suppliers are not on the hook for the materials," Wood explains. Teradyne considers that to be money well spent, he adds. "With our kind of business, being responsive to the customer is more important than worrying about how much inventory you have."

Visibility across suppliers
Maintaining visibility down to the parts and material level across a number of enterprises is no easy task. For this, Teradyne relies on an application from Kinaxis called RapidResponse. This software integrates data from Teradyne's and Flextronics' enterprise resource planning systems with weekly information from suppliers' information systems in order to provide a multi-enterprise view of inventory and ready access to production planning data.

The software also allows Teradyne to see how an order or a change in demand will affect Flextronics as well as its suppliers. "If we change demand, we can see how that demand cascades down from the contract manufacturer to the component supplier," says Wood. "The idea is to see everything in our plants and our contract manufacturers' plants as if we were all one big connected family." That detailed view of parts inventory also allows Teradyne to reallocate supplies from one site to another rather than simply buying more of them.

Teradyne also uses the RapidResponse application to send its key suppliers forecasts of the type and number of parts that Flextronics is likely to be ordering from them. "We manage the future buy forecasts with them, partly because the same part is ordered for more than one plant," says Wood. "Flextronics does not have a real easy way to consolidate them."

Additionally, Teradyne relies on RapidResponse to track demand for parts used in typical systems configurations and develop forecasts for future demand from all sites—information it then uses to determine what materials it will authorize component suppliers to purchase. That has led to a marked reduction in lead times. "Before the program started, a part might have a 10- to 15-week lead time on purchase orders," says Wood. "Now the lead time might be zero to two weeks. Our ability to forecast 10 weeks out is not that good. So this is a big benefit."

An added benefit has been a reduction in parts costs. Improved visibility of components has helped Teradyne reduce its liability for high-dollar-value parts ordered under the Supply Chain Express program by 15 to 30 percent.

The rewards of restructuring
To date, Teradyne has seen a number of benefits from its outsourcing and supply chain reconfiguration initiatives. For starters, the company has seen inventory drop from US $214 million in 2004 to US $80 million in 2007. Inventory turns have risen to 5.02 per year compared with 2.26 four years ago. Teradyne now keeps only 10.35 weeks' worth of stock on hand, in contrast to 22.97 in 2004. (Note: these numbers are for all of Teradyne's business units.)

Some of those savings have come from moving production and assembly work to Asia, where many of the testing houses are located. "Most of our customers are now in Asia, which is a change from five years ago," says Wood. At one time, he explains, Teradyne was building boards in China, shipping them to the United States for assembly, and then shipping most of the finished systems back to Asia. By relocating assembly and testing work to Suzhou, Teradyne was able to save on freight and manufacturing costs as well as materials costs—which Wood says have dropped by 5 to 6 percent annually. The move has also put Teradyne closer to its customers, allowing it to be more responsive to their needs.

The supply chain reconfiguration has also supported Teradyne's shift to a demand-pull, or make-toorder, strategy, which allows the contract manufacturer to delay ordering high-value parts until they're actually needed. "We can more easily respond to demand changes inside of five weeks because of the ... Supply Chain Express [team's] efforts with suppliers to shorten the ordering lead time," Wood says. The result has been speedier order deliveries. In the past, a customer had to wait between 13 and 16 weeks for a piece of test equipment. Now the wait is only about eight weeks on average, and, when necessary, a system can even be built in two weeks. Wood adds that the decision to use the Suzhou facility for production, assembly, and testing has further shortened lead times by eliminating the need to ship components between plants.

Although Teradyne initially was reluctant to turn its production and testing operations over to outsiders, the company reports that it has seen no decline in its production quality. "We have been extremely successful," Wood says. "And we haven't seen any major business hiccup in regard to our responsiveness to customers."

Wood expects that Teradyne will shift more work to Flextronics over time but says he doesn't see any immediate change in procurement policy. For the foreseeable future, Teradyne will continue to own the relationships with the suppliers who make the high-tech, high-dollar parts that are unique to his company. That's partly because Teradyne enjoys a great deal of leverage with suppliers like those that provide ASICs. But it's also because Teradyne finds the knowledge gained through close collaboration with suppliers to be invaluable to its new parts design and development efforts. "It helps us [to] understand the supply," says Wood, "because that impacts our designs."

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